Investment Real Estate: Which Type of Investor are You?

In the bustling world of investment real estate, there are many mixed messages going around which can lead to many questions on behalf of a prospective investment borrower:

What types of real estate should I invest in?
What do banks want from me?
Will I need a mortgage loan or a commercial loan?
Should I just flip this property?
Should I do a rehab project?

The questions are endless and they are all worth asking; however, the important questions to start with should be: “What type of investor am I?” and “What can I do to put myself in the best possible position to get approved for traditional bank financing?” In this article, we will discuss three different types of real estate investments and what traditional banks look for when evaluating a loan request for each type.

 

The “Weekend Warrior” Investor
1-4 Unit Residential Real Estate

We call the first level of real estate investor a “Weekend Warrior.” These individuals are the most common type of investor in the real estate market. Their property types include single family homes, duplexes, triplexes, and four-unit buildings. “Weekend Warrior” investors usually maintain a full-time job with W-2 income with their real estate investments as secondary sources of income (hence “Weekend Warrior”). This is usually one’s first step into real estate investments. You maintain the reliability and stability of a day-to-day job, while you research and work on your future investments.

If you’re just beginning to dabble into real estate investing, there are some financial boxes you will need to check when attempting to obtain a loan through a bank (such as Standard Bank!). Banks will look at several factors such as:

  1. Your experience with real estate investing
  2. Sources of primary (W-2) income
  3. Personal credit history
  4. Personal liquidity – Do you have enough funds in a checking or savings account for a down payment (usually 20%) as well as funds in reserve in the event of an emergency?
  5. Does the lease in place for the property support the debt service and all other expenses associated with the property such as taxes, insurance, and utilities?

It’s recommended that a borrower put together a pro-forma analysis of the property that consists of expected annual rental income and expenses. Many investors make the mistake of assuming that the lease income will need to pay for the monthly loan payment and that’s it, but there are many other expenses that are incurred while owning the property (i.e. taxes, insurance, utilities, repair costs, management fees, future vacancies). A fair starting point is to charge rent to cover at least 1.25x your annual expenses.


“Mixed-Use” Investor
Multi-level and Mixed-use Properties

Mixed-use investment real estate is exactly as it sounds: the property has a mixed use. Common layouts for this type of real estate consist of a commercial business on the first floor and residential apartments upstairs. Think about driving down the main street of your local town. Everyone looks at the business on the first floor, whether it be a flower shop, restaurant, laundromat, hardware store, or bakery. But what about that second or third level? What is up there? All we see are windows. What seasoned real estate investors see is additional rental income. Mixed-use properties tend to be some of the better income generators out there. First, because commercial space rental income is much higher than residential with longer lease terms. Second, because of all those windows above. Those windows consist of more residential units that can help supplement the commercial lease below them. This comes in handy in the event the entity that is occupying the commercial space decides to move out and you need to find another tenant. That additional residential rental income can support the debt service while there is a vacancy on the first floor.

In addition to the five items that banks analyze in the first section, there are some additional items banks consider with mixed-use properties:

  1. Banks will look a little closer at the lease for the commercial entity. Ideally, the bank would like to see the term of the lease be the same as the term of the loan. Or, there should at least be some options stated in the lease for the tenant to extend or renew their lease.
  2. With larger spaces comes larger purchase prices, larger expenses, and larger loan amounts. This translates into larger down payments. A bank will really focus on liquidity in this case to make sure the borrower can handle all of the increased expenses associated with a bigger space.

Typical investor demographics for this type of property is similar to the type of real estate. It’s a “mixed bag.” Some “Weekend Warriors” will have some properties like these on the side. Some full-time investors will have a portfolio of these properties that they use as their primary income driver.

 

“The Big Time” Investor
Commercial Real Estate

This category of commercial real estate is extremely broad, and once you are at this level, you have reached “the big time” as a fully vested real estate investor. This level of investing may consist of a:

  1. Single building that houses an individual business
  2. Large building that houses a lot of individual commercial tenants (i.e. office parks)
  3. Strip mall setup that houses 1-10 businesses
  4. 5-100 unit residential apartment building

Just as the category is broad, the purchase prices and structures are broad as well. A single building holding one business may have a purchase price of $300,000 while a large office building or strip mall may have a purchase price of $3,000,000. Although the price points can have a wide variance, banks will still look at each request somewhat similarly. In addition to the items listed in the first two investment options, banks may consider the following:

  1. How are the commercial tenants performing? Does their income support the lease payment they make to the borrower every month?
  2. How long have the tenants of the building been there? Is there a lot of turnover and vacancy in the building?
  3. What kind of area is the property located in? Is it a desirable area for a business to operate or for a significant number of residents to live in? Is the area facing an economic downturn?

As you can see, there is a significant focus on the status of the tenants and geographic area when it comes to this type of commercial real estate. Your tenants (and potential tenants) are the sources of your funding so both the bank and you, as an investor, don’t want to assume a lot of risk when it comes to the main source of your income.

 

As described above, investment real estate is just as unique as the investors that purchase them—which is why it’s near impossible to apply a cookie cutter approach to their loan requests. This is where community banks, like Standard Bank, stand apart from other banks. Standard Bank, for example, has the ability to look at each individual project and customize a loan option that works for both the bank and the borrower. Not many banks are willing to customize solutions if you don’t fit into their “box.” So if you want a solution that matches your investment style, be sure to work with a community bank (or even better, Standard Bank!). You’ll appreciate the customization they offer to make your real estate investment goals a reality.

 

About the Author

Christian DeSarbo, vice president and commercial relationship manager, has over eighteen years of experience in commercial and retail banking. At Standard Bank, Christian manages a portfolio of commercial clients; establishes new commercial relationships, and delivers financial solutions, inclusive of underwriting commercial loans. He has extensive experience with commercial real estate lending in the Pittsburgh and Beaver County regions. Christian is a graduate of Penn State University and volunteers his time as Treasurer on the Beaver County Christian School Board. If you would like to meet with Christian, please reach out to him at (412) 781-1465.